David M. Demshur - Core Laboratories NV Gwendolyn Y. Schreffler - Core Laboratories NV Christopher S. Hill - Core Laboratories NV Lawrence V. Bruno - Core Laboratories NV.

Sean C. Meakim - JPMorgan Securities LLC Byron K. Pope - Tudor, Pickering, Holt & Co. Securities, Inc. Stephen D. Gengaro - Stifel Financial Corp. Scott A. Gruber - Citigroup Global Markets, Inc. James Wicklund - Credit Suisse Securities (USA) LLC Chase Mulvehill - Bank of America Merrill Lynch Thijs Berkelder - ABN AMRO Bank NV.

Good morning, and welcome to the Core Lab Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to David Demshur, Chairman and CEO. Please go ahead..

Thanks, Austin. Good morning in North America, good afternoon in Europe and good evening in Asia-Pacific. We'd like to welcome all of our shareholders, analysts and most importantly, our employees, to Core Laboratories' third quarter 2018 earnings conference call.

This morning I am joined by Dick Bergmark, Core's Executive Vice President; Monty Davis, Core's COO; Chris Hill, Core's CFO; who will give the detailed financial review; Gwen Schreffler, Core's Head of IR, who will make comments regarding Core's projections for the fourth quarter; and Larry Bruno, Core's President, who will present the detailed operational review.

The call will be divided into five segments. Gwen will start by making remarks regarding forward-looking statements. We'll then review the current macro environment, updating industry trends related to optimal well spacings, well positioning and parent-child well relationships.

We will then review Core's three financial tenets, which the company employs to build long-term shareholder value. We will then set some financial targets for 2019, and then have some comments around the announcement of the retirement of Monty Davis.

Chris, will then follow with a detailed financial overview and additional comments regarding building shareholder value, followed by Gwen, discussing Core's fourth quarter 2018 outlook and a general industry outlook as it pertains to Core's prospects.

Then Larry will go over Core's two operating segments, detailing our progress and discussing the continued successful introduction of new Core Lab technologies, and then highlighting some of Core's operations and major projects worldwide. Then, we'll open the phones for a Q&A session.

I'll turn it back over to Gwen, for remarks regarding forward-looking statements.

Gwen?.

Before we start the conference this morning, I'll mention that some of the statements that we make during this call may include projections, estimates and other forward-looking information. This would include any discussion of the company's business outlook.

These types of forward-looking statements are subject to a number of risks and uncertainties relating to the oil and gas industry, business conditions, international markets, international political climate, and other factors including those discussed in our 34 Act filings that may affect our outcome.

Should one or more of these risks or uncertainties materialize or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in the forward-looking statements.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

For a more detailed discussion of some of the foregoing risks and uncertainties, see Item 1A Risk Factors in our Annual Report on Form 10-K in the fiscal year ended December 31, 2017, as well as other reports and registrations filed by us with the SEC and the AFM. Our comments include non-GAAP financial measures.

Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing our third quarter results. Those non-GAAP measures can also be found on our website. With that said, I'll pass the discussion back to Dave..

Thanks Gwen. First on the industry investment trends and then comments on horizontal parent-child well relationship. Core is encouraged that operating companies are buying into operating within free cash and emphasizing returns on invested capital as demanded by today's investors.

This trend benefits Core's core who's clients tend to be technologically sophisticated and are heavy users of technology over commodity-driven solutions offered by drillers, pressure pumpers and wireline providers.

During the third quarter, Core hosted several conference calls for various industry analysts to discuss optimal well spacing, downsizing, upsizing, well positioning and parent-child well relationship.

Core is uniquely positioned to provide technology-driven datasets to determine optimal well spacing and well positioning to eliminate the deleterious effects of well bashing and well interference.

To optimally determine well spacings and to better cite well location, associated with pad drilling, Core's most technologically advanced clients are cutting vertical cores through the entire pay-zone and also taking various reservoir fluid samples throughout the pay-zone.

Detailed analysis of the core and fluid samples provides information to the operator on micro-lithologies, rock competence, rock mechanics, crude oil types and qualities, all datasets necessary to determine optimal well spacing and well positioning.

As horizontal wells are drilled, completed and stimulated, Core's FLOWPROFILER EDS completion diagnostics technology can verify that wells are not bashing or interfering with neighboring wells on the pad, eliminating lost production and maximizing producible reserves.

This becomes critical as well pads will soon see 24 or more wells being drilled from that single pad location.

The combination of Core Lab Reservoir Description and Production Enhancement technology maximizes our client's free cash flow and their return on invested capital, their current investment goals and ensures Core Lab revenue growth will be greater than activity levels once again in 2019.

A second trend, the industry will continue to add perf clusters per stage yielding less stages, while lateral lengths are near maximum owing to frictional forces.

Perf clusters per stage could increase from 5 to 6 per stage to as many as 15 per stage, reducing the time and cost for well completion and stimulation programs owing to the overall lower stage count.

We are also starting to observe the use of micro proppants in complex completions in the Permian Basin with some 200-mesh sand being incorporated into the stimulation program. Core continues to test the effectiveness of both 200 and 400-mesh sand.

The last and most important trend for Core is that client discussions have continued to increase for international and deepwater, the longer-cycle projects that will be needed to meet future production demand.

The foreshadow of this increase in activity has been evident in the 20 FIDs approved in 2017 with another 25 to 30 expected to be approved in 2018.

Revenue from longer-cycle projects have been mainly absent from Core's Reservoir Description revenue streams dating back to 2015, and should start to bolster revenue – Reservoir Description revenue in 2019.

Core's revenue opportunity usually occurs three to four quarters after the FID has sanctioned as rigs need to be mobilized, wells drilled and core and fluid samples taken and then returned to our laboratories. Q1 2018 Reservoir Description results marked the bottom of the international and deepwater cycle.

Increases in global demand, increases in net decline curve rate and decreases in global inventories have been occurring since July of 2016 coupled with steeply falling production in Mexico, Venezuela, Colombia, Angola, Libya, Iran and China has tightened the global market to the point where longer dated barrels on the curve have increased price and ensure greater international and deepwater investment for the future.

Remember the decline curve always wins and never sleeps. Now to review the three financial tenets by which Core has used to build shareholder value over the 23-plus year history of being a publicly traded company.

During the third quarter, Core generated almost $20 million in free cash and converted 11% of every revenue dollar, and 88% of net income into free cash, one of the highest in all oilfield services. In 2019, Core sets a target of converting over 85% of our net income into free cash with free cash exceeding net income during the second half of 2019.

Once again, Core produced oilfield industry-leading return on invested capital for the 36th consecutive quarter with a return on invested capital of 28%, over double of Core's weighted average cost of capital. Core's 28% ROIC is over three times out of any other company listed in the OSX. For 2019, Core targets ROIC exceeding 40%.

Also during the third quarter, Core returned over $24 million back to our shareholders. And in 2019, Core will continue to return all excess capital back to its shareholders via quarterly dividends and share repurchases. As referenced in our Q3 EPS release, Monty Davis intends to retire at the year's end after 36 years of service at Core.

Monty was the architect and has executed on producing consistent industry-leading margins, free cash flow conversion of revenue and net income and return on invested capital. Monty was always a tough taskmaster, but always fair in his approach to make Core Lab a better company every day.

Monty has done an excellent job of building the company's operational management bench, and we have every confidence that Larry Bruno, will continue to strongly carry the baton that Monty has handed him. I'll now turn the call back over to Chris for a detailed financial review.

Chris?.

Thanks, David. During the third quarter we completed the acquisition of Guardian Global Technologies on September 26, on which Larry will expand upon in his operational discussion. The acquisition's operations did not contribute to the third quarter financial results for Core Laboratories.

However, incremental costs associated with the acquisition were incurred during the third quarter. The guidance we gave on our last call and past calls, specifically excluded the impact of any FX gains and losses and assumed an effective tax rate of 15%.

So, accordingly our discussion today excludes any foreign exchange gain or loss for current and prior periods, as well as the business acquisition cost for the current period and is reflective of continuing operation. Now, looking at the income statement.

Revenues from continuing operations were $182.1 million in the third quarter, up 12% year-over-year from third quarter 2017, which is primarily attributable to our business in North America.

Of this revenue, service revenue, which is more international, was $124.1 million for the quarter, up over $6.9 million and over 6% from the same quarter last year. Product sales which are tied more to North American activities were $58 million for the quarter, an increase of over 27% or $12.4 million year-over-year.

Our product sales revenue is primarily driven by the completion of wells in the North American markets. And more specifically the activity associated with the completion of each stage in a wellbore. Moving on to cost of services. At 71% of service revenue remained relatively consistent from previous quarters.

Cost of sales in the third quarter was 69% of product sales revenue, which is consistent to last quarter and has significantly improved from the 76% for the same quarter last year. We continue to see improvements in our operating leverage and the absorption of our fixed costs on higher levels of revenue.

Additionally, we have made investments this year to automate and improve efficiencies in our manufacturing processes, which will benefit future operating results once fully implemented. G&A for the quarter was $13.3 million, which is fairly consistent with the last few quarters. We expect G&A to be around $51 million for the full year.

Depreciation and amortization for the quarter was $5.7 million, consistent with the last several quarters. Depreciation and amortization expense is expected to be approximately $23 million for the full year. EBIT ex-items for the quarter was $36.7 million, up over 36% from prior year, and continues to represent best-in-class EBIT margins of 20%.

GAAP EBIT was $34.9 million. Income tax expense for the quarter was $4.7 million using an effective tax rate of 15%. On a GAAP basis, income tax expense for the quarter was $9.4 million, which includes some discrete adjustments in the third quarter, which were not forecast for the third quarter and are not forecast in future periods.

As discussed in prior earnings calls, the effective tax rate will continue to be somewhat sensitive to the geographic mix of earnings across the globe, and the impact of items discrete to each quarter.

Net income from continuing operations ex-items for the quarter was $28.4 million, up over 38% or $7.9 million from $20.5 million in the third quarter of last year. GAAP net income for the quarter was $22.2 million. Earnings per share from continuing operations ex-items was $0.64, also up 39% year-over-year. GAAP EPS was $0.50 for the quarter.

Now, we will move on to significant aspects of the balance sheet. Receivables stood at $143.3 million, up from $133.1 million at year-end 2017, as a result of growing revenue, but importantly, our DSOs remain consistent and improved slightly for the quarter at 66 days.

Inventory at $47.2 million, up $7.4 million sequentially as demand for product continue to expand and the addition at quarter end of approximately $2.5 million associated with the acquisition of Guardian.

Inventory turns have remained consistent at 3.8 for the current quarter, and we expect our inventory turns to continue at similar levels for the remainder of the year. And now onto the liability side of the balance sheet.

Our long-term debt ended the quarter at $296 million, up $227 million at year-end, of which approximately $47 million was borrowed during the third quarter to fund the acquisition of Guardian. Looking at cash flow, in the third quarter, cash flow from operating activities was $23.8 million.

And after paying for our $4.1 million in CapEx, our free cash flow in the quarter was $19.7 million. We expect capital expenditures for the year to be in the $23 million to $24 million range. And we will continue to adhere to our strict capital discipline as we evaluate the capital expenditure opportunities based on client demand.

Our free cash flow conversion ratio which is free cash flow divided by net income continues to be one of the highest in the industry at 88% for the quarter. We believe this is an important metric to shareholders when comparing company's financial results, particularly for those shareholders who utilize discounted cash flow models to assess valuation.

I will now turn it over to Gwen for an update on our guidance and outlook..

Thank you, Chris. Our fourth quarter 2018 outlook is unchanged from the 8-K release on October 4, 2018. Worldwide crude oil markets are currently undersupplied as seen in current global crude oil inventory and days of consumption and inventory data reported by the International Energy Agency.

The IEA's most recent estimated worldwide demand projections remain strong with 1.3 million and 1.4 million additional barrels of oil per day needed in 2018 and 2019 respectively. Renewed investment at a global level is critical in order to meet future supply needs.

Oil company recognition of the need for investment is evident by the 25 to 30, final investment decisions estimated to be announced in 2018, with approximately 25 announced year-to-date.

The Company believes fourth quarter 2018 international exploration and production activity levels will be flat, with most international development spending continuing to be funded largely from operating budgets.

We expect fourth quarter international activity improvement to remain low, with the slower than expected increases in the international rig count. Additionally, we believe the average fourth quarter 2018 U.S.

rig count will increase slightly sequentially, but the growth in onshore completion activity continues to flatten and drilled-but-uncompleted wells inventory levels will continue to rise. Any company exposed to completion activities will be impacted by these trends. We also believes the U.S.

completion activity will decrease until transitory industry takeaway constraints are resolved in the Permian Basin of West Texas. We continue to be encouraged by the increased focus of our major clients on investments in technology that will yield higher shareholder returns.

The exploration and production companies adopting value versus the volume metrics tend to be the more technologically sophisticated operators and form the foundation of Core's worldwide client base.

Client planning for international and offshore projects is progressing and as these projects move forward, Core's activity sourced from these markets is expected to improve in 2019. Our Reservoir Description segment international client project discussions continue to increase in alignment with FIDs announced year-to-date.

Activity levels and revenue opportunities for FIDs and the emerging international recovery are expected to have a positive impact on financial performance in 2019. The revenue opportunity for Reservoir Description occurs once the well has been drilled and core and fluid samples are taken and analyzed.

Our Production Enhancement segment's impact from the completion intensity trend should be evaluated basin-by-basin, for example, as other companies in the Oilfield Service sector have publicly discussed, takeaway constraints in the Permian are having a negative impact on completion activity.

As the operators shift activity to other regions outside the Permian, Core is capable of responding quickly as diagnostic services are mobile and our distribution network provides completion products to all basins throughout the U.S.

As the industry moves through the fourth quarter of 2018, Core's outlook for international activity remains flat and we see a decline in completion activity due to Permian takeaway constraints when compared to the third quarter 2018.

Therefore, we expect consolidated fourth quarter 2018 revenue of approximately $173 million to $176 million and operating income of approximately $28 million to $31 million, yielding operating margins of 17%. Using the projected fourth quarter operating income and an effective tax rate of 15%, Core projects EPS of $0.48 to $0.54.

Depending on many variables that factor into the calculation of the effective tax rate, Core anticipates its 2019 effective tax rate could be approximately 20%. With that guidance, we'll turn the call over to Larry for an operational review..

Thanks, Gwen. First, I'd like to thank our 4,600 employees around the globe for providing innovative solutions, integrity and superior service to our clients. Recently, I had the good fortune to participate in the operational review meetings across a broad cross-section of our business segments.

The enthusiasm and dedication of Core Lab's employees are infectious and drive our success. I'm privileged to be part of such a strong team. Looking first at Reservoir Description.

It was a very significant year-over-year increase in the demand for Pressure-Volume-Temperature or PVT studies from the Western Canadian sedimentary basin during the third quarter.

Operators working in unconventional volatile oil, natural gas and condensate plays such as the Montney and Duvernay Shale formations need a thorough understanding of phase behavior, hydrocarbon composition, dew point or bubble point, formation volume factors, viscosities and gas-oil ratios.

It's critical to validate these reservoir fluids properties through highly accurate physical laboratory measurements made at reservoir temperature and pressure.

These direct physical measurements provide key fixed data points for reservoir modeling, thus creating more robust prediction of reservoir performance and helping to maximize the operators return on invested capital.

As a result of the increase in demand for reservoir fluid analysis, Core's Canadian operations completed a significant upgrade and expansion of their reservoir fluid characterization laboratories in the third quarter.

These upgrades includes a introduction of the only full visual high-temperature, high-pressure, mercury-free automated PVT cell in the Canadian market. The company will continue to deploy proprietary state-of-the-art PVT and Enhanced Oil Recovery technologies to meet the growing demand for these services.

During the third quarter of 2018, Core Lab received sufficient client support to initiate its second Enhanced Oil Recovery Joint Industry Project, aimed at evaluating engineered gas injection opportunities in unconventional shale reservoirs.

This new Joint Industry Project will focus on the Permian-age Wolfcamp formation in the Delaware and Midland Basins of West Texas.

Like Core's first unconventional EOR Joint Industry Project announced in the second quarter of 2017 for the Eagle Ford formation, the Permian study will be customized to address the unique challenges associated with Permian Basin geology and hydrocarbon properties.

Reservoir condition, laboratory experiments using proprietary Core Lab methods and technologies, such as High Frequency Nuclear Magnetic Resonance will be used to determine the optimal approach for field scale EOR programs.

In addition to these Joint Industry Project's, Core is also performing an increasing number and variety of unconventional EOR studies on a proprietary basis. Turning now to Production Enhancement. As Chris mentioned earlier, Core is happy to announce that it completed the acquisition of Guardian Global Technologies in the third quarter.

Guardian, based in Wales is a technologically sophisticated designer and manufacturer of downhole implementation that is utilized by international oil and gas operators for well completions. The acquisition of Guardian expands Core's proprietary portfolio of patented Production Enhancement technologies.

Moreover, Guardian's technologies fully complement Core's integrated approach to perforating oil and gas wells, augmenting Core's proprietary top-to-bottom perforating tool strength.

Core Lab expects Guardian's addressable downhole capabilities combined with Core's differentiated perforating systems and energetics to lead to the introduction of disruptive product solutions in 2019, expanding its participation in the multi-billion dollar perforating market.

Also during the third quarter of 2018, a West Texas-based operator was encountering high breakdown pressures on a horizontal unconventional well while using traditional shaped charges. This complication increased horsepower requirements and hampered their fracking program.

Core Lab provided a customized solution utilizing its unique HERO PerFRAC perforating charges in combination with its patented Kodiak Enhanced Perforating System.

The pairing of these proprietary Core Lab technologies, generated both industry-leading consistent hole sizes in a radial fashion around the wellbore, as well as a closely sequenced, high output secondary energetic event that is highly effective at fracturing the formation in the near-wellbore area.

The operator changed their cluster design during the completion process to accommodate this enhanced perforating strategy.

The combination of HERO PerFRAC and Kodiak technologies lowered the breakdown pressures by a significant 25%, reducing horsepower requirements on the frac job, and allowing the operator to stimulate the target zone at an optimal rate.

Using the combination of HERO PerFRAC and Kodiak technologies allowed the operator to put away higher concentrations of frac sands and fluids which produced greater Stimulated Reservoir Volume.

Greater Stimulated Reservoir Volume yields higher return on invested capital for Core's clients and aligns with the industry trend of deploying technology to maximize production from unconventional reservoirs.

Core Laboratories completion diagnostic services saw a growing success in the Canadian market in the third quarter as clients shifted to more plug-and-perf completions, specifically in the Duvernay and Montney formation.

Core's recently introduced preview technology (27:05) an on-site tracer service has been one of the reasons for their strength in this market. Customers that have been using dissolvable Bridge Plugs in the toe of long reach laterals require the use of Core's preview (27:19) diagnostic service.

The preview (27:20) technology gives Core's clients a very rapid yes or no answer to identify if all stages in the well are open to flow.

Core's SPECTRASTIM and SPECTRASCAN technologies have also seen increased utilization, helping clients in plug-and-perf wells by allowing them to directly measure how effectively each stage is being stimulated and also serving as a guide to optimize future completion designs.

Moreover, these proprietary completion diagnostics have demonstrated the superiority of the plug-and-perf approach, versus other completion methods in terms of maximizing the Stimulated Reservoir Volume. That concludes our operational review. We appreciate your participation and Austin will now open the call for questions..

Thank you. And our first question will come from James West with Evercore ISI. Please go ahead. James, your line is live, you may proceed with your question. And we'll move on to our next question, which is from Sean Meakim with JPMorgan. Please go ahead..

Thank you. Hey, good morning..

Good morning, Sean..

So I'm hoping to unpack the guidance a little bit more. How do we think about the expectation for top line versus incremental margins in the quarter? So thinking about, is something in line with what we've heard from pressure pumpers of low double-digit type of revenue decline quarter-over-quarter.

Is that kind of a reasonable place to start? And if you use that and assume that Reservoir Description is fairly flat in terms of top line and margin, then your guidance would reflect – keeping the revenue decline static, something like a decremental between 30% and 65% would be kind of how you'd go across that range.

And so it will be great to hear more about how you think the decremental can unfold, depending on how severe the top line impact is? And then just – is there anything else to – anything else that we're missing in terms of understanding some of the drivers there for the quarter?.

No, Sean. I think you hit it pretty close. What's baked into the guidance with regard to completion activity for Production Enhancement is that could be roughly about 5% or more decline in the completion activity. We saw that completion activity already start to decline from August to September. So we believe that that could be in excess of 5%.

And then, yes, we've got international activity flat which would be relative to Reservoir Description, and the one-third of Production Enhancement. So you're spot on with the decremental. And if the operators do shift to other areas, we're going to be prepared and able to deploy very quickly in order to capture our part of this completion..

Got it. Thank you for that. And then just, within Production Enhancement, is there anything else that we should be talking about? We are learning more about the perforating systems business in terms of analysts and public investors as more of these competitors are just spending more time with us. And so, we are seeing some capacity come online.

Anything else you could elaborate on with respect to pricing dynamics. It's been a pretty healthy market for a long time, for most of the time. Customer preference is changing around premium charges.

Just thinking of other things that we should be addressing that could also be influencing the numbers or would you isolate it strictly to budget exhaustion and some of these near-term challenges with the completions activity on the part of the E&P?.

Yes Sean, I've got some comments on that. One is the acquisition of Guardian and their next-generation addressable switch. That's going to give Core Lab some exposure to the preloaded gun systems that we haven't really participated in up to this point. So that might be north of 15%, maybe 20% of the market. So that gives us some entrance into that.

Also, as I mentioned in my comments, we see some real promise in this intersection of Kodiak technologies, which are proprietary to Core Lab and our HERO PerFRAC technologies. Think about the carry-through for an operator.

If he can cut down his horsepower requirements by softening up the terrain if you will by using HERO PerFRAC closely followed and when I say closely, nearly instantaneously followed by a secondary energetic event from Kodiak, if the results continue as that gets deployed in other areas, we could see some nice uptick of that additional technology..

Yeah, you can figure the combination of the use of those two energetics as kind of a mini frac in the near-wellbore region, which opens up Stimulated Reservoir Volume. So that's the critical factor in increasing flow and recovery from that zone that's been stimulated. So look for more sophisticated combinations of energetics being used..

And with respect to what you're seeing in the marketplace on pricing dynamics, are things getting more competitive, are you seeing any changes there? Or still really just the primary focus is on pushing the ball down the field on your differentiated technology?.

Yeah, we think primarily our clients are more interested in greater Stimulated Reservoir Volume, which gives them greater returns as opposed to what the pricing model would be. So no affect on price..

Got it. Very helpful. Thanks, everyone..

Okay, Sean..

Your next question comes from Byron Pope with Tudor, Pickering, Holt..

Good morning, team..

Good morning, Bryon..

Just wanted to probe a little bit more on the Q4 guidance if I could. And so I just want to understand the commentary about completions activity being down August to September.

Is that just an industry comment? Or are you already seeing the impact on the Production Enhancement segment so far in the quarter?.

So that – Byron that's reported by the EIA. That's just a data that we've evaluated from August to September. So it's – what I would say flat at this stage. And so we anticipate that the completion activity, if it's flat now, we think that that continues to go – we think that goes down from here until the capacity comes online.

And we think the capacity item doesn't unfold until the back half of 2019 from a takeaway standpoint..

Yeah, Byron, I think that piece you guys put out a couple of days ago with respect to projecting October completions to be down 6% in the U.S., we think that was spot on..

Okay. And then what I was trying to get at, Dave, is just though there's some conservatism baked into the guidance just in an environment where there's uncertainty as to exactly how much activity curtails into year-end. So that was the genesis for the question, so I appreciate that..

Yeah. And I think that is correct. You see that we are projecting essentially Production Enhancement to be down about 10% sequentially quarter-over-quarter. So that's what we're baking in. If it's not that great, okay, we got some upside..

Perfect. And then just one additional question on Guardian, given where they're based, I don't want to assume that their geographic mix is skewed toward outside North America. But I guess, my question is, it seems as though there are some tremendous pull-through opportunities for Guardian, just given Owen's leadership position in North America.

So any color you can give, just on the regional revenue for mix, revenue mix for Guardian and the opportunity set as being part of the Production Enhancement Group going forward?.

Yeah, Byron. Larry here. You're right. We see some real opportunities going forward. First, start with the technology. Taking the technology that Guardian brings, that's going to allow us to develop new technologies and bring them to market faster.

But also our Production Enhancement products segment has much greater exposure to the market than Guardian had as a standalone enterprise. So, we'll be able to leverage that very nicely, I think, fairly quickly into the North America market, and also for our global clientele.

So we've got now a little more horsepower by bringing the two entities together, and a lot more market exposure. And as I mentioned earlier, we'll move from being exposed to about 80% of the global perforating systems market to now being able to participate in 100% of it..

It's really helpful. Thanks, Larry. I appreciate it..

Yeah..

And our next question comes from Stephen Gengaro with Stifel. Please go ahead..

Thank you. Good morning..

Hello, Stephen..

Two questions for me guys. The first, you talked about increasing sort of perf charges per cluster.

Can you talk about just what do you think that means for overall demand for frac charges as we go forward, relative to kind of like to the – what's the market opportunity? And is it changing because of that? Or is it just – are they just being used in fewer instances?.

If you look, Stephen, year-over-year, U.S. completions are up about 21%. Our product sales are up 26%. So you can see that it is outgrowing what the demographics are for those completions. We think that continues down that trend. Again, all to get more Stimulated Reservoir Volume..

Do you think it accelerates based on what you've seen over last year? That's good data.

But is it – is that gap getting larger, you think, the growth rates relative to completion growth rates?.

Yes. The more – we will see more charges per stage, and we're projecting that to go up from an average right now of about five to six to as many as 15. Early days on that, but we will see that over the next year or two..

And Stephen in a sort of an optical way of looking at this maximizing surface area that's critical. And so the more rock it can be rubble-ized and impacted by the frac job through more intense clusters the better..

Okay. That's helpful, and that seems to bode well for Production Enhancement's relative growth in 2019 and 2020. The second question I have was just overall, as it stands now and you guys, obviously, have a real good view of what is going on at the reservoir level. And I know it's tough to tell from a timing perspective as we kind of go through 2019.

But others have sort of discussed kind of a 10% international growth rate in 2019 versus 2018.

And giving your history on the Reservoir Description side, is that an unreasonable growth rate to think about for you guys for next year in the (40:09)?.

We wouldn't argue with that number..

Okay, great. Thank you for the color..

Okay, Stephen..

Your next question comes from Scott Gruber with Citigroup. Please go ahead..

Good morning..

Good morning, Scott..

A lot of good information in the prepared remarks.

Dave, did I hear you correctly that you expect 2019 ROIC to exceed 40%, up from 28%?.

Correct. That would be an exit rate for us in 2019..

Okay. That's what I wanted to clarify..

Yeah, because if you remember Scott back in 2014 through mid-2015, we were putting the ROIC up that exceeded 50%..

Right, right..

So, we think we will trend that way..

Got it. Because you had a comment that you expect to be North American completion activity to pick up in the second half of the year. So it's an exit rate that you're thinking about. I got it..

Correct..

And can you – I may have missed it, but could you have the revenue run rate and EBITDA run rate for Guardian? Could you provide that?.

It's really de minimis at this point, because it's just a – it was a technology purchase to get some of their technology into our quiver. So right now essentially it's de minimis. I would say that in the fourth quarter it's probably going to be neutral to earnings, maybe some addition first half of next year.

But I wouldn't change our operating model that much..

I guess, it's more of a second half impact?.

Yeah..

It sounds like....

That's what we are....

Got it. That's it. Thank you..

Okay, Scott..

Your next question comes from James Wicklund with Credit Suisse. Please go ahead..

Good morning, guys. Hi, David..

Hello, Jim..

I was going to ask what the ROIC of Guardian is with de minimis numbers and you're just buying technology (42:24) doesn't have any. And you talked about being neutral to earnings probably in Q4 and maybe or maybe not added to the earnings in 2019.

But from an ROIC perspective, this can't be accretive to your ROIC, but you're talking about ending next year at 40%.

Can you talk about the returns in your respective segments, and what's driving your ability to get to 40% considering buying companies like Guardian, which is a great buy, it doesn't strike me as inherently really high return business?.

Yeah. But new products were going to roll out Jim, especially with their addressable switch, gets us to not only 80% of perforating market, but a 100%. We think that actually adds – is additive to a ROIC of 40% by the end of next year.

We're gearing up second half of them to be incrementally adding to our margins in Production Enhancement, which right now are 26%..

Okay..

And that produces a – that's going to produce a ROIC that will be additive to the 40% target that we have..

Okay. My follow-up if I could, you guys have been fabulous over the years about returning capital to shareholders through dividends and buybacks, and all. Guardian is one of the first acquisitions you've made in a while and you haven't done that.

Can you discuss your decision-making process for capital allocation right now and the possibility of continued M&A?.

Yeah, this is Chris. There's really no change....

Hi, Chris..

...hey, good morning. There's really no change in the way we look or think about capital allocation. The dividend will remain our first priority. And then when we do start generating free cash flow over the dividend, we will start to look at repurchasing shares. So we do look at share repurchases opportunistically.

So, there could be pockets where we dip into the market. But for acquisitions, we still kind of take a view that we'd like to develop our technologies internally. But occasionally, we do see something that fits nicely in with what we're already doing, and we can leverage that across our global network. And that's how we....

There's an awful lot for sale right now, that's what makes me – since you got this, this is a great opportunity..

Yeah, we really don't have any other material acquisitions that we're looking at right now. And again, I think, Chris, stressed it, we tend to want to develop from within. As you know it produces higher return..

Yeah..

And we have been working on this adjustable switch for a couple of years. And we thought that this was an instantaneous cure of the development of that technology. And that's why we're willing to go ahead and acquire Guardian. We have worked with them over a number of years, and thought it was the right move to make..

Okay. Okay, gentlemen. Thank you very much. Appreciate it..

Okay, Jim..

Your next question comes from Chase Mulvehill with Bank of America Merrill Lynch. Please go ahead..

Hey, good morning, everybody..

Good morning, Chase..

I guess a few questions on Reservoir Description. I guess the first one, you've thrown out the 10% revenue growth potential for 2019.

If you get that kind of revenue growth, what kind of incrementals do you think you can generate on that 10% revenue growth Reservoir Description?.

60%, Chase, is what we target..

Okay, all righty. Good to hear that.

And then on the 40% return on invested capital, what kind of margin do you think that puts you at for Reservoir Description?.

Probably approaching 20% again..

Okay. All righty..

Right now (46:31) 15%..

Yeah. And then can you just kind of explain a little bit about Reservoir Description on the revenue side. What's going on in the fourth quarter? Typically you see some seasonality, some positive seasonality in the fourth quarter, and then it kind of reverses in the first quarter.

So, kind of talk about what's going on in the third quarter? And then what it might would mean for first quarter? Should we be modeling revenues not down in the first quarter, because of what's happened in the fourth quarter?.

I might model those down a little bit. I think we will see a little bit greater revenue in Q4, not materially over what we saw in Q3. But perhaps down a little bit in Q1 as the seasonal forces take hold..

Okay. Last one, and I'll turn it back over. And so you're guiding to Reservoir Description basically revenues flat and margins flat too.

Correct?.

Correct, in fourth quarter..

Okay. All righty..

Chase, I'll add one thing to that. There's a little bit of seasonality there. We've got some projects going up in the Arctic, and it'll depend on what the freeze brings us in terms of when those projects move forward..

Okay.

Was that a comment towards 1Q, is that what you were saying Larry?.

Well, whether we might see some things happen in Q4 or things happen in Q1..

Got it. Okay..

And then once that activity takes place, then we've got to get rocks and fluids back in the lab, and then we start generating revenue on them. So a little bit of a lag behind that, and it's a little hard to forecast when that activity is going to settle in..

Okay. Perfect. All right. I appreciate the color..

Thanks, Chase..

Your next question comes from Thijs Berkelder with ABN AMRO. Please go ahead..

ABN AMRO. Sorry. Guys, first I want to thank Monty for all his years with the company, and for the great performance. Many questions already having been answered.

A couple of specifics, Guardian Global, when exactly can we expect the first contribution to land? Is that Q3 or Q4 2019?.

Well, you're going to get some contribution, because it is a neutral look at Q4. But additive to earnings probably step out mid-part of next year is what we're geared up for..

Yeah. I think it will get better as the year progresses, and they start to get more of that technology integrated with what we already have..

Okay.

And does it require additional CapEx spending from your side?.

Not materially more..

We think their products start to come in around midyear and we'll start seeing the effect of that in the second half of the year..

Okay. Clear. Then on working capital. Working capital year so far is going up every quarter.

What is the expectation there for Q4? And can you specifically give the reasoning behind the creep up?.

Well, Thijs, this is Chris. I think that's natural when you're in a growing environment. So as revenues grow and product sales grow, you will see the receivables mirror that. What's more important is that, our DSOs have actually improved this year. Our inventory turns have stayed at a high level.

So as we move into Q4 with revenues slightly down, which is Production Enhancement, I think you should expect receivables to come down with that and inventory levels to come down as well. So we actually might see a benefit to cash flow in the fourth quarter from a reduction in working capital.

But it's been mirroring that, just like we would expect it to react....

No. I agree there. I was expecting that as well. But just checking what your view is there. Then coming back on free cash flow and your statements there, let's say in the third quarter, of course, primarily because of the cash out for working capital, you still suffered a cash out after dividend of $5 million.

And the acquisition pushes your leverage up to 1.8 times EBITDA, how are you....

Yeah, I think....

...as the new CFO looking at leverage going further? And what is now timing do we need to go for a bigger share of buybacks also? Also, you're guiding for a recovery of the business.

So, in principle, that is indeed accompanied with a further extension of working capital?.

Right. Just on your point about our leverage ratio for our debt agreement, it's actually an adjusted EBITDA. So, looking in at that post-acquisition and adding that debt, we're a little over 1.5 when you look at our ratio as we're measured against the covenant. So, we're comfortable with the level that we are at now.

I think we would be comfortable with that moving up a little bit more, but I think we would watch that, and also in tandem with what the energy or the industry is doing.

So, once you start to see a stronger recovery in Reservoir Description also contributing to the growth, I think it gives us more comfort when we're covering with dividend with free cash flow and we see some of that more stability in the industry, you could see us enter the share repurchase market..

Okay. Good to hear. Then you primarily in the press release also in the warning for Q4 talked about the – let's say the pressure on U.S. shale. Also, Canada has suffered a lot from let's say related effects. What has happened? And you explained let's say an upgrade in Canadian Reservoir Description.

But what are you seeing in the Canadian market in terms of activity on your side?.

Yeah, I think the Canadian market, we're pretty encouraged there by the request for technologies both on the Production Enhancement and on the Reservoir Description side. The Montney and Duvernay formations are pretty complicated.

Your – in some places you are in a condensate area, some places you're in a natural gas-producing area, some places you're in an oil-producing area, volatile oil. And so clients are having to address the complexities that come with that phase behavior and being on the edges of different phase behavior in those areas.

So, I think overall I would say the Canadian market is far from being the robust area that it was before the downturn. But clients gravitate towards technology that answers their questions, and so we think we'll do a little bit better than the market up there in general..

Okay..

The activity..

And then maybe finally a bit of a hot topic nowadays, Saudi Arabia. Saudi Aramco is clearly pushing up the volumes they want to deliver.

How is that being reflected on your side in your activity levels?.

Well, as many of our investors have heard me comment before, we only have one client in Saudi Arabia. They're a very good client, we appreciate the work that they've sent us over the years and continue to send us. We have a local operation there to provide some services.

But we also provide services for them in our Houston Advanced Technology Center as well. So we don't comment specifically on the levels of activity from a client just that Aramco has been. And we see continued -will continue to be an important client for us..

Yeah, and I'd just add that we see activity levels in the Middle East actually picking up and forerunning other international locations..

Yeah. Yeah. That was my guess as well. And therefore I was a bit puzzled by the let's say the 10% growth projection for 2019, because the press release more or less suggests it primarily should come from international, let's say deepwater..

That is correct..

This is not much more – yeah. Okay. That's correct..

Okay. Thijs, thank you..

Okay. Yeah, thanks..

We have a follow-up from Stephen Gengaro with Stifel. Please go ahead..

Thank you. Just a quick one. It came up before. Return on invested capital, when you think about the two segments and deployment of capital into the two segments. Can you – historically what has the pattern been. And I think RD has been higher.

But how should we think about that going forward?.

We are making some – we're in the middle of making some automation – investments in automation in our Production Enhancement manufacturing line. So those are attracting capital investment right now. We see very nice return opportunities there. So that's playing out.

But over decades of being at Core Lab, I've yet to see a good idea that didn't get funded..

Yeah, Stephen, we have a form that has to be filled out, and it calculates what a return on the project is going to be. And essentially the higher return projects get funded, but lower ones do not..

Right. And I would also add that those are typically client-driven technologies. So if the clients are wanting it, and we see the returns there, we're going to invest in that..

And sometimes that's venue-related. So for example, earlier in the year we announced expansion of a lab in Alaska, and that we were putting a lab into Qatar as well to keep up with the anticipated client demand..

Right. And we're making additional investments in the Production Enhancement Group as well to bring some automation and efficiencies into those projects..

Okay, great. Thank you. And just a quick one on CapEx.

CapEx next year should it be fairly close to 2018 levels?.

Yes..

Great. Thank you..

Okay, Stephen..

Austin, I think we're going to go ahead and wrap up. So in summary Core's operations continue to position the company for activity levels in the fourth quarter of 2018. And we know significant challenges await.

However, we have never been better operationally or technologically positioned to help our clients maintain and expand their existing production base. We remain uniquely focused and are the most technologically-advanced reservoir optimization company in the Oilfield Service sector. This positions Core well with the challenges ahead.

The company remains committed to industry-leading levels of free cash generation and returns on invested capital with all excess capital being returned to our shareholders via dividends and future opportunistic share repurchases.

So in closing, our 93rd quarterly earnings release, we want to thank all of our shareholders and analysts that follow Core, and as already noted by Larry Bruno, the Executive Management and Board of Core Laboratories gives a special thanks to our worldwide employees that have made these results possible.

We are proud to be associated with their continuing achievements. So, thanks for spending some time with us this morning, and we look forward to talking you on our next update. Good bye for now..

And thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect..